Tax and the City briefing for September 2012

Off-payroll arrangements

The government is continuing its efforts to clamp down on the use of personal service companies to avoid tax and national insurance contributions (NICs), this having been exposed to be as rife among public sector appointees as in the private sector. The HM Treasury review published in May revealed over 2,400 off-payroll engagements in central government departments and their arm’s length bodies. The review quite rightly notes that an off-payroll arrangement does not necessarily indicate tax avoidance: the individual concerned might be genuinely self-employed and paying income tax and NICs by self-assessment, or supplied by an agency and on the payroll of the agency, or working through a personal service company and drawing the profits as salary or operating IR35. (IR35 being shorthand for the ‘intermediaries’ legislation in ITEPA 2003 Part 2 Chapter 8 which imposes an obligation on any entity through which a worker provides his or her services to a client, in circumstances where a direct contract between worker and client would be in the nature of an employment contract, to operate PAYE and account for employer NICs.) The problem is one of transparency and the review made two key recommendations:

• that the most senior staff – ‘board members and senior officials’ – be on the payroll, save in exceptional circumstances; and
• that departments seek formal assurance from contractors with off-payroll arrangements lasting more than six months and costing over £220 per day that income tax and NICs are being met.

A Procurement Policy Note published on 24 August gives guidance to departments on how to go about the assurance bit, which all seems jolly sensible – in fact, so much so, it is difficult to see why anything further should be required in relation to the most senior staff.

What is of real concern here is the proposal, set out in a joint consultation issued by HM Treasury and HMRC at the same time as HM Treasury’s review, that any ‘engaging organisation’, whether in the public or private sector, be obliged to treat all ‘controlling persons’ (ie, persons with managerial control over a significant proportion of the engaging organisation’s employees or budget) as on the payroll for tax purposes. It is as yet unclear whether this new rule would be intended to operate within the framework of IR35 so as merely to shift the liability to operate PAYE and account for NICs from the intermediary to the client in the case of controlling persons – in other words, whether it would apply only to controlling persons who are disguised employees in the IR35 sense – or whether it would cover anyone who met the definition of ‘controlling person’ irrespective of whether they were a disguised employee or in fact a genuine consultant providing their services as a self-employed person or an employee of a different organisation. What about the director from a leading management consultancy firm appointed to provide high-level strategic advice to a division of HM Treasury? Or the local accountant in private practice who is employed by a family-owned manufacturing business to oversee budget? This consultation closed in August and it is hoped that the responses will be sufficient to deter HMRC from using its sledgehammer to crack any nuts.

EBTs settlement opportunity

HMRC has published a list of frequently asked questions (FAQs) designed to enable employers to assess whether they should be taking advantage of an opportunity to settle disputes relating to the use of employment benefit trusts (EBTs) to avoid or defer income tax and NICs or to circumvent the annual and lifetime allowances which apply to registered pensions schemes. The FAQs make it clear that HMRC is not offering any discounts. Nevertheless, a carrot is being dangled in the form of a ‘paragraph 59’ agreement (FA 2011 Sch 2 para 59) which may provide relief from charges under the disguised remuneration (DR) rules going forward.

To put it at its simplest, if an employer accepts that an allocation by an EBT in favour of an employee of contributed money (say £1m) prior to commencement of the DR rules gave rise to income tax and NICs charges and pays up as part of the settlement process, then a para 59 agreement will prevent further employment income tax and NICs charges arising under the DR rules when the money (which, with investment return, is now say £1.7m) is actually paid by the EBT to the employee. The investment return of £700,000 may still constitute taxable income under a different head of charge but the fact that NICs will be calculated with reference to the £1m and not the £1.7m will almost certainly represent a saving. Paragraph 59 agreements are in principle available not only for allocations made during ‘open’ years of assessment but also for years outside normal assessing time limits.

GAAR update

At a stakeholder meeting on 5 September, HMRC presented its developing thinking on a number of aspects of the draft GAAR, ahead of the consultation closing on 14 September. The most interesting points probably relate to the role and constitution of the Advisory Panel. HMRC seem to accept that the panel should, like the Office of Tax Simplification (OTS), have an independent chairperson and that this chairperson would select from a ‘pool’ the persons who would deliver their opinion(s) on any particular case. Despite much criticism, HMRC has, however, not yet conceded that the panel – supposedly designed to bring a business perspective to bear on what can or cannot be regarded as reasonable – should not include HMRC representatives. Indeed, HMRC stated rather cryptically that it would expect the panel to have a ‘closer link’ to HMRC than, say, the OTS.

Helpfully, HMRC is anticipating that individual panel members will be able to produce dissenting opinions and that, if the matter is pursued to litigation, any dissenting opinion will be available to the courts. As for publication of panel opinions, HMRC continues to cite difficulties to do with taxpayer confidentiality although this still feels like a pretext for just not wanting what HMRC would regard as an ‘adverse’ opinion to be used as a safe harbour.

Unfortunately, the plan remains that HMRC will draft the guidance for the panel to approve. There is a proposal for an ‘interim’ panel to approve the initial guidance, which is already being drafted for publication along with updated draft legislation in December (the problem being that, prior to enactment of the GAAR, there is no statutory basis for the panel’s existence). A proposition that the interim panel be drawn from the GAAR Study Group did not find much favour at the meeting and there were calls for greater representation from the business community.

Four dead men (not)

Yet another CGT avoidance scheme bit the dust in Blumenthal v HMRC [2012] UKFTT. The taxpayer had sold some shares to O2 in consideration for sterling-denominated loan notes structured as non-qualifying corporate bonds (non-QCBs). The effect of the loan notes being non-QCBs – a status secured by inserting an option for O2 to redeem the loan notes in US dollars on the basis of the exchange rate prevailing three days prior to the redemption date – was that the share-for-note exchange did not trigger a CGT disposal of the shares and instead the taxpayer’s gain in the shares was rolled over into the loan notes. So far, so benign.

With the redemption date and crystallisation of the rolled-over gain looming, the taxpayer entered into some further planning which involved varying the terms of the loan notes in two ways. The first variation was that, subject to the size of movements in the sterling–dollar exchange rate during a ‘relevant period’, any dollar amount payable on redemption was to be calculated using the exchange rate prevailing on the actual redemption date as opposed to the date three days before. The second variation involved reducing the redemption amount to 3% of the nominal value of the loan notes in circumstances where either an original noteholder had transferred the notes or – an alternative scenario inserted at the insistence of O2, to give them an outside chance of being able to redeem at 3% – at least four of six specified noteholders had died. Happily all six survived – the O2 proponent of the ‘four dead men clause’ might have had some explaining to do had the relevant noteholders started dropping like flies …

The first variation was intended to result, once the exchange rate had moved sufficiently within the relevant period (highly likely), in the loan notes becoming qualifying corporate bonds (QCBs). The transition from non-QCB to QCB status would have crystallised a gain or loss calculated by reference to the market value of the loan notes immediately prior to transition, albeit such gain or loss would be ‘held over’ until redemption of the QCB (here a matter of days later). The First-tier Tribunal (FTT) accepted that the first variation should be respected as capable of switching the status from non-QCB to QCB. The only reason that the original share-for-note exchange had been effective to roll over the gain on the shares was because the inserted dollar currency redemption option endowed the loan notes with non-QCB status and HMRC had not challenged this routine planning technique: an effective acknowledgment of the prescriptive nature of the rules and their immunity to purposive construction.

The second variation was designed to depress the market value of the loan notes immediately prior to their transition from non-QCB to QCB status, so that transition triggered a loss not a gain (with the old rolled-over gain on the shares consequently disappearing into the ether). Leaving to one side a rather fundamental implementation flaw (and an alternative basis for concluding that the second variation was ineffective), the FTT decided that ‘market value’ in the relevant statutory context was (unlike the term ‘qualifying corporate bond’) susceptible to a purposive interpretation and that it meant the real as opposed to the artificially depressed value of the loan notes. In which case the transition from non-QCB to QCB status did not crystallise a loss but instead the rolled-over gain from the original shares.

Helen Lethaby, Tax Partner, Freshfields Bruckhaus Deringer